Instructor Guide Introduction

Module 9 Instructor Guide Introduction This comprehensive small-business tax education program is designed for selfemployed small-business owners of all kinds. This audience includes a wide variety of business types, educational levels, and experience. For this reason, these materials have been organized for maximum flexibility and use in many settings and instructional situations. The Users Guide found at the beginning of the Instructor Resource File contains a description of the course design and each module. In addition, you will find teaching suggestions for the use of training aids, course materials, and course evaluations. Modules are available to cover the following small-business tax topics: Information for all Businesses 1. Business Assets: Depreciation and Selling Depreciated Property 2. Business Use of the Home 3. Employment Taxes 4. Excise Taxes 5. Starting a Business/Recordkeeping 6. Schedules C and SE, and Form 1040-ES 7. Self-Employed Retirement Plans 8. The Small Business as a Partnership 9. 10. S Corporation/Corporation For each program module, the program consists of materials for the instructor (an instructor guide and a set of transparency masters) and materials for the student (a study guide and a workbook). The student materials do not depend on an instructor's input and can be used for independent study. The instructor guide for each module contains an overview of the module; a plan for assessing the level of student knowledge before using the module; a list of teaching materials needed (including the provided transparency masters and other materials); background on the teaching topics; a pre/post-assessment quiz; and Instructor Guide 1

quiz answers. Students are given background information and explanations within their study guide and use the consumable workbook for exercises and case studies (the solutions for which appear in the back of the student workbook). Additional IRS forms and publications may be helpful to you and your students but are not included with this program. Single copies of these forms and publications can be ordered by calling 1-800-829-3676. Overview Tip income is taxable income. Employees report their tips to their employer so he or she can include them when reporting wages to the Internal Revenue Service (IRS). The IRS has determined, through experience, that tips should equal a certain percentage of gross receipts. If the tip amount reported to the employer for inclusion in taxable income is not high enough, the employer of a large establishment must allocate tips to each directly tipped employee based on the amount of business done. This module explains the difference between reported, unreported, and allocated tips. It defines a large establishment and describes the methods large establishments can use to allocate tips. It describes how to fill out Form 8027, Employer's Annual Information Return of Tip Income and Allocated Tips. In this guide, you will also find teaching hints and additional examples to help you explain these tax issues to your class. Pre-Assessment Follow the steps listed below to assess what your students already know and what they want to learn. Ask students to indicate whether they are familiar with the IRS tip reporting rules. Do they know what amount of tips triggers reporting to the employer? Do they know how service charges differ from tips? Do they know what their share of social security and Medicare taxes is on their employees' tips? Ask questions about your students' businesses. Do the students know how to determine if they own a "large establishment?"ask students to indicate whether they are familiar with the tax meaning of these phrases: directly tipped and indirectly tipped, gross receipts from food and beverage operations (other than nonallocable receipts), good faith agreement. Decide, based on the information gathered from the first three steps, the level of instruction that will benefit most of the students. Distribute the short, pre/post-assessment quiz found at the end of the instructor guide. If this is given before and after completion of the unit, you and your students can determine how much they have learned. Instructor Guide 2

Teaching Materials You will need the following transparencies when teaching this module: 9-1. Form 4070A, pages 1-3 9-2. Form 4070A, page 4 and Form 4070 9-3. Form 8027 9-4. Employee Tip Reporting 9-5. Large Establishment 9-6. Tip Income Allocation 9-7. Gross Receipts 9-8. Employer Penalties 9-9. Form W-2 The text contains sufficient information so that participants do not need additional IRS publications and forms to successfully complete the module. If, however, you believe you'd find a copy of the materials listed below helpful when preparing to instruct this module, just call the IRS toll-free at 1-800-829-FORM (3676). IRS Publication 334, Tax Guide for Small Business (For Schedule C or C-EZ (Form 1040) Filers) IRS Publication 1244, Employee's Daily Record of Tips and Report to Employer IRS Publication 531, Reporting Tip Income IRS Publication 15, Circular E, Employer's Tax Guide Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return Form 941, Employer's Quarterly Federal Tax Return Form 8027, Employer's Annual Information Return of Tip Income and Allocated Tips Form 8846, Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips Form W-2, Wage and Tax Statement Instructions for the above forms There is no charge for most IRS forms and publications. Instructor Guide 3

Teaching Topics Reporting Tip Income WHO MUST REPORT Employees who receive tips of $20.00 or more in a month are required to report the tips to their employer by the tenth day of the month following the one in which they receive the tips. The penalty for not reporting tips to an employer when required is 50 percent of the employee social security (or railroad retirement) and Medicare taxes due on the tips, in addition to the tax you owe. EXAMPLE Tips earned in March must be reported no later than the tenth of April. If the tenth falls on a weekend or legal holiday, the due date is the next weekday that is not a holiday. The longest period covered by the employee's report is one month. The employer is allowed, however, to require reports more often. The Employee Tip Reporting transparency shows the items required on employees' reports: * employee's name, address, and social security number * employer's name and address * period covered * amount of tips received * employee's signature and date Tips of less than $20.00 in any month to an individual do not have to be reported to the employer. The tips, however, do have to be reported on the individual's income tax return. RECORDKEEPING Display Form 4070A. Your students should impress upon their workers the importance of accurate recordkeeping. The IRS provides forms for this purpose. Form 4070A, Employee's Daily Record of Tips, has lines for each day in the month and columns for necessary information. The columns list cash tips and charged tips received by the employee and tips the employee paid out and to whom. Instructor Guide 4

Show the transparency of Form 4070. The end of the month total from Form 4070A is transferred to Form 4070, Employee's Report of Tips to Employer, and turned in to the employer. In the example shown, December tips are reported in January. These tips will be treated for tax purposes as having been received in January. Juan's $275 will be reported on his Form W-2 for 1997, not 1996. If Juan did not make a report to his employer because he received less than $20 in tips in December, the tips would be reported on Juan's 1996 tax return. Form 4070 and Form 4070A are included in IRS Publication 1244 along with instructions for their use. Employees, however, may keep records and make their reports in any way they wish; they need not use the IRS forms. Employees should keep their tip records for at least 3 years. These records may be needed at a later date to verify tip income. Form 8027 LARGE ESTABLISHMENTS Show your class the transparency of Form 8027. Large food or beverage establishments must file Form 8027, Employer's Annual Information Return of Tip Income and Allocated Tips, by the last day of February each year. A large establishment is one providing food or beverages for consumption on the premises that normally employed more than ten workers a day during the preceding calendar year and, in addition, is an establishment where tipping is customary. When counting employees, employers must count all employees, not just tipped employees. An individual who owns 50% or more in value of the stock of a corporation that runs the establishment is not considered an employee for this purpose. A new large food or beverage establishment must file Form 8027 when, for 2 consecutive months, the 80-hour test is met. This happens when the average number of hours worked each business day in the month by all employees is greater than 80 hours. The owner adds together all the hours worked during the month by all employees and divides that figure by the number of days the business was open during that time. The first return covers the period running from the first payroll period after the test is met until the end of the year. Instructor Guide 5

EXAMPLE Classic Cuisine opened for business in September. In October and November, the average aggregate number of hours worked each day by the restaurant employees was greater than 80. Form 8027 will cover December. ALLOCATING TIP INCOME When to Allocate The Tip Income Allocation transparency summarizes the situations requiring allocation. Tip income is allocated when the total amount of tips reported to the employer by his employees is less than 8 percent of the gross receipts (or a lower percentage approved by the IRS). The allocable amount is the difference between the amount reported and 8 percent. This difference is allocated among the directly tipped employees who reported less than 8 percent of their share of gross receipts. Show the class the Gross Receipts transparency. For allocation purposes, gross receipts do not include nonallocable amounts such as carry out amounts, state or local sales taxes, or receipts to which a service charge of at least 10 percent has been added. Gross receipts with service charges of less than 10 percent are included because service charges are added to the employees' Forms W-2 as wages. Your business is not covered by these rules if you add a service charge of 10 percent or more to 95 percent or more of your food or beverage sales. Employees who report at least 8 percent of their share of the establishment's gross receipts as tip income should not have any tip income allocated to them. This is true even if the overall reported tip income is not 8 percent of the establishment's gross receipts. An employee's share is computed by totaling the bills credited to a particular employee and multiplying that total by 8 percent. How to Avoid Tip Allocation Tip income does not need to be allocated if employees report tips equaling at least 8 percent of the employer's gross receipts. If employers wish to avoid tip allocation, they should insist on complete and accurate tip reporting by their employees. If the actual tipping rate of customers is less than 8 percent, the employer or a majority of the employees may petition the IRS to grant a percentage rate lower than 8 percent, Instructor Guide 6

but not less than 2 percent. The petition must include all relevant information including details of the establishment and its operation, its location and clientele, each meal's menu, and copies of Form 8027 (if any) filed for the last three years. How to Allocate Good Faith Agreement A good faith agreement is a written agreement between employer and employees agreeing to a formula for allocating tips. Two-thirds of the employees in each affected category must agree. A category is an occupational grouping such as servers and bartenders. If a good faith agreement is used, a copy of it must be sent each year to the IRS with Form 8027. If you do not use a good faith agreement, you must use one of the following methods to make the allocation. Gross Receipts Method The gross receipts method can best be explained using an example. EXAMPLE Dominic's Ristorante has five directly tipped employees. The gross receipts for the year less carry-outs and taxes (there are no service charges) are $75,000. The amount of tips reported by directly tipped employees equals $4,600 and tips reported by indirectly tipped employees equals $700. Directly Tipped Gross Receipts Tips Employee (taken from customers' bills) Reported Beverly $17,000 $1,020 Mario 10,000 540 Joanna 9,000 730 Johnny 18,000 1,100 Louis 21,000 1,210 Totals $75,000 $4,600 Instructor Guide 7

1. Multiply the establishment's gross receipts, minus nonallocable amounts, by 8 percent. Remind your students who haven't worked with percentages recently that multiplying by 8 percent means multiplying by 0.08. $75,000 x 0.08 = $6,000. 2. Subtract from this the tips reported by employees who are not tipped directly by customers. $6,000 - $700 = $5,300. 3. Multiply the figure from step B by the amount of each employee's share of the establishment's gross receipts, and then divide by the total of the establishment's gross receipts. This gives the amount of each employee's share of the 8 percent calculated in step A. In order to do this, the employer must keep records of each person's share of receipts. (See When to Allocate, above.) Directly Tipped Employee s Share of 8 percent of Gross Employee Receipts Beverly $5,300 x $17,000/$75,000 = $1,201 Mario 5,300 x 10,000/75,000 = 707 Joanna 5,300 x 9,000/75,000 = 636 Johnny 5,300 x 18,000/75,000 = 1,272 Louis 5,300 x 21,000/75,000 = 1,484 Total $5,300 4. Subtract, from each person's share of the 8 percent, the amount of tips that person reported. If an employee did not report an amount at least equal to his or her share, there is a shortfall. Add all the shortfalls Directly Tipped Employee's Tips Employee's Employee Share of Reported Shortfall 8 Percent Beverly $1,201 - $1,020 = $181 Mario 707-540 = 167 Joanna 636-730 = 0 Johnny 1,272-1,100 = 172 Louis 1,484-1,210 = 274 Total Shortfall $794 5. Subtract, from the 8 percent of gross receipts, all the tips reported by all employees (both directly and indirectly tipped). This results in the amount to be allocated among the directly tipped employees with shortfalls. $6,000 - $4,600 = $1,400 - $700 = $700. This is the allocable amount. Instructor Guide 8

6. Multiply the amount in step E by each employee's shortfall and divide by the total shortfall. The results figured here are each employee's share of allocated tips and the total amount of allocated tips. Tips are not allocated to indirectly tipped employees. Employees with Allocable Shortfall Allocated Shortfall Amount Ratio Tips Beverly $700 x 181/794 = $160 Mario 700 x 167/794 = 147 Johnny 700 x 172/794 = 152 Louis 700 x 274/794 = 242 Total $701 (The total of allocated tips in step F is $701 rather than $700 because of rounding the numbers.) The tips allocated to employees in step F are shown on the employees' Forms W-2. Hours Worked Method This method allocates tips based on the number of hours worked by each employee. In the gross receipts method, the fraction in step C by which each employee's share of 8 percent of the gross is multiplied is the employee's gross receipts divided by the establishment's gross receipts. In the hours worked method, the fraction is the number of hours worked by the employee divided by the total number of hours worked by all the directly tipped employees. This method can only be used if fewer than the equivalent of 25 full-time employees are employed during any pay period. COMPLETING FORM 8027 Display the transparency of Form 8027. Form 8027 is straightforward. It merely brings together information from the employer's records. The lines are selfexplanatory. Lines 1 and 2 of Form 8027 require that employers keep records of the total of charged receipts on which tips were charged, and the amount of the charged tips. Point out to the class that while the total amount of tips to be allocated is written on line 7 along with the method used, the amount allocated to each employee is not put on this form. Instructor Guide 9

The number of directly tipped employees goes on line 8. This figure includes all who worked at any time during the year, not just those working at the end of the year. Regardless of the IRS district that the employer resides in, Form 8027 is sent to the Internal Revenue Service Center, Andover, MA 05501. Form W-2 Refer the class to the exhibit of Form W-2 in the student text. Display the Form W-2 transparency. Allocated tips are not included as wages on employees' Forms W-2 but are put in Box 8 on Form W-2. The employer withholds no income, social security or Medicare taxes on allocated tips. Reported tips are included in Box 1 along with wages and service charges. The service charges are considered wages, not tips. The employer must withhold income tax and social security and Medicare taxes (FICA taxes) from the wages and tips in Box 1. If there are not enough wages to cover the withholdings, the employee should make other funds available to the employer for this purpose. The employer pays his or her share of FICA taxes on the employee's wages and reported tips. The employer pays the federal unemployment tax (FUTA) on reported tips and wages, but not on allocated tips. Employees pay their share of FICA taxes on allocated tips and unreported tips of more than $20 per month with their income tax. If an employee has adequate records showing tips received, the employee should report that amount and not the allocated amount, by filing Form 4137, Social Security and Medicare Tax on Unreported Tip Income, with Form 1040, U.S. Individual Income Tax Return. Credit for employer social security taxes paid on employee tips. Beginning in 1994, a new general business credit is available for food and beverage establishments. The credit is equal to the employer portion of social security and Medicare (FICA) taxes paid on tips received by employees of the establishment. Only tips received from customers for providing food or beverages for consumption on the premises of the establishment are taken into account. The credit is reduced if Instructor Guide 10

employees are paid below the federal minimum wage. No deduction is allowed for any amount taken into account in determining the credit. No portion of the unused business credit for employer FICA taxes may be carried back to taxable years ending before August 10, 1993. Use Form 8846 to claim this credit. A food or beverage establishment is any trade or business (or portion of a business) which provides food or beverages for consumption on the premises and in which employees serving food or beverages are customarily tipped by the customers. For more information on this credit, see Form 8846, Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips. Penalties The penalty for filing a late information return is based on the length of time the return is late. The penalty applies if you do not file by the due date, if you do not include all the required information, or if you report incorrect information. Late Information Returns The following penalties apply to late information returns: 1. If the return is filed within 30 days after the due date, the penalty is $15 for each return, up to a maximum of $75,000 a year. 2. If the return is filed after the 30-day period but by August 1, the penalty is $30 for each return, up to a maximum of $150,000 a year. 3. If the return is filed after August 1 or never filed, the penalty is $50 for each return, up to a maximum of $250,000 a year. Small businesses pay the same penalty for a return, but the maximums are lowered to $25,000, $50,000, and $100,000 a year respectively. A small business is one with average annual gross receipts of $5 million or less for the last 3 years, ending before the calendar year in which the return is due, or since business began if shorter. Instructor Guide 11

Late Payee Statements If you do not furnish a required statement to a payee by the required date, there is a penalty of $50 for each statement you do not furnish, up to a maximum of $100,000 a year. The penalty also applies if you do not include all required information, or if you report incorrect information. Pre/Post Assessment Quiz Answers 1. $20 2. directly 3. indirectly 4. tenth 5. 8 6. 8027 7. tipping, ten 8. 80-hour, two 9. carry out 10. report to their employer 11. tips reported by employees 12. good faith agreement, gross receipts method, and hours worked method 13. $50 14. the employer's share of social security and Medicare (FICA) 15. W-2 Instructor Guide 12

Pre/Post-Assessment Quiz 1. Employees must report tips of or more per month to their employers. 2. Employees who receive tips from customers are tipped employees. 3. Employees who receive tips from other employees are tipped employees. 4. Employees report their tips to their employer by the day of the month following the month the tips are received. 5. Employees who report less than percent of their gross receipts may have tips allocated to them. 6. Large food or beverage establishments are required to file Form, Employer's Annual Information Return of Tip Income and Allocated Tips. 7. In a large food or beverage establishment, is customary, and more than employees worked on a typical day during the preceding calendar year. 8. New large food or beverage establishments file the tip information form when they meet the test for months in a row. 9. Gross receipts do not include, among other things, sales. 10. Allocated tips are theoretically tips that employees did not. 11. Allocated tips are usually 8 percent of gross receipts minus the. 12. The three methods of tip allocation are (1), (2), and (3). Instructor Guide 13

13. There is a per return penalty for not filing a required information form. 14. Employers do not have to pay on allocated tips. 15. An employee's share of allocated tips is reported by the employer on Form. Instructor Guide 14